| China’s financial system has been always featured with the control of interest rate and the quota of credit before the liberalization reform. During the financial reforming process, it is required that the government should gradually reduce its direct control over the financial market, which in turn should be the determinant of the interest rate. Meanwhile, we should enhance the institutional supervision structure of finance and deepen the reform of money and capital market. In order to weaken the shock of financial reform over the economy, China decided to take progressive reforming scheme of financial liberalization. As practice shows,30years of financial liberalization reform has made a sound success and effectively drove the development of real economy. The financial liberalization reform has changed the running environment of China’s economy and finance, and it will be inevitably impact the transmission of the monetary policy.This thesis focuses on the monetary policy issues during the process of financial liberalization. The stability of money demand is the precondition for the central bank to take money supply as the intermediate object of the monetary policy, because a steady money demand means a steady velocity of money. According to the quantity equation of money, only with a steady velocity of money can the influence of the money supply-the intermediate object of monetary policy, over the level of price and income, which is the ultimate aim of monetary policy, be predicted. The stability of money demand or velocity does not mean an absolute fix. It means a steady or predictable growth rate. It is a very complex process to decide the money demand because it is influenced by many variables. Money demand is mainly determined by the portfolio selection of the economic agents in microeconomy and influenced by scale variable and opportunity cost variable. Besides, China is now going through the financial liberalization, which means the institutional variable will also exert some influence on money demand. Yet generally speaking, money demand is an endogenetic variable. Although the money demand might become unstable because the institutional changes maybe lead to the change of opportunity cost during financial liberalization, it can still keep steady because of the comprehensive influence of many other variables. Hence, the study of money demand is not only a theoretical issue but an empirical one. This is also the reason why this thesis conducts a large number of empirical analyses. Another precondition for effectiveness of China’s monetary policy is the controllability of money supply, or in other words, the capability of central bank in controlling money supply. If the central bank could not control this intermediate object as it sets, let alone its control and realization of its ultimate target. Certainly, money supply is not totally exogenetic and also influenced by many endogenetic factors in financial market. Therefore, the central bank faces great difficulties in controlling money supply. Furthermore, even if our money demand is steady and the central bank can also control money supply, the realization of monetary policy’s ultimate target still has to rely on its effective transmission. The transmission mechanism of monetary policy is so complex that it forms a sound challenge for the policy’s effectiveness in itself. As a result, it is of sound theoretical and policy importance for the thesis to analyze the set models of money demand and supply and the model of monetary policy transmission with China’s relevant statistics.This thesis consists of nine chapters.Chapter1is introduction.Chapter2is a review over the theories and empirical analyses of money demand. This chapter firstly summarizes the money demand theories. It mainly analyzes and compares the money demand theories of Keynesianism and Monetarism. Based on these classic theories, the author studies the evolution and development of money demand’s empirical analysis and Chinese researches’ status quo in this field. The theories as well as the empirical analyses of money demand focus on its stability, which is influenced by scale variables, opportunity cost variables and institutional variables.Chapter3discusses the influence of money demand over the monetary policy in choosing its intermediate target. Economists always believe that monetary policy does exert some influence over the output level. Yet policy makers are still not capable of predicting or controlling the ultimate target of the monetary policy, as a result, they first need to figure out a best controllable variable as intermediate target so as to realize its ultimate target. The intermediate target of monetary policy mainly means money supply or interest rate. However, as the theoretical analysis shows, the central bank could not choose both money supply and interest rate as its intermediate targets at the same time. It must make a choice. If it chooses money supply as the intermediate target, a stable and predictable money demand function is an important precondition for the effectiveness of such monetary policy. So this function is of vital importance to the policy. The IS-LM model analysis shows that, if the more unstable the IS curve over the LM curve, the more steady the monetary policy could control the output level with money supply as its intermediate target. Therefore, the central bank should choose money supply as the intermediate target of the monetary policy. Chapter4analyses the impact of financial liberalization over the monetary policy transmission.In this chapter, the author divides financial liberalization into three categories:firstly, the liberalization of interest rates; secondly, the application of indirect monetary policy tools, which specifically means the cancel of direct control over credit; thirdly, the enhancement of financial market’s function, depth and range. The core of financial liberalization is the liberalization of interest rates. This chapter reviews the related documents on financial liberalization, especially interest rate liberalization policies and the feasible mechanism of these policies in influencing the operation of monetary policy. Financial liberalization would exert important impact on the credit and money supply of the bank, thus influencing the transmission of the monetary policy. Besides, it would also lead to the change of money demand and the change of income and interest rate elasticity. Furthermore, it would also underlines the relationship between money demand and interest rate, thus resulting in strong fluctuation of money demand during financial liberalization. The stability of money demand would influence the transmission of monetary policy.Chapter5illustrates the money demand and velocity during the process of China’s financial liberalization mathematically. The reform of China’s financial liberalization develops an effective environment for the operation of the financial system and preliminarily establishes the frame of financial liberalization. Such reform promotes the deepening of finance, enhances the capability of financial intermediaries in allocating resources, thus helping the economy keep a steady growth and the macro economy run stably. Meanwhile, during the process of financial liberalization, the reform of economic and financial system, the liberalization of financial asset pricing and the emergence of numbers of new financial tools would also lead to the change of money demand of velocity. In this chapter, the author firstly analyzes the structural changes of China’s financial institutions during the financial liberalization. As China is now witnessing the economic transformation, regular and irregular financial institutions are co-existing. Although regular financial institutions has developed rapidly since the reform and opening up, large numbers of irregular ones still exist because of the financial repression. This thesis measures the scale and development of the regular financial institutions with the ratio of M2to GDP and the measures that of the irregular financial institutions with the ratio of MO to M1and M2. As the statistics show, since the reform and opening up, China’s value of M2/GDP has always kept a rising trend, which means our financial deepening has been gradually enhanced. MO/M1and M0/M2ratio was maintained at a high level before the1990s. Although China had conducted economic system restructuring for a long time before the1990s, financial liberalization still stayed in a relatively low level. High MO/M1and M0/M2ratio reflected that to certain extent considerable financing behavior had taken place in irregular financial institutions. After the1990s, China accelerated the pace of financial liberalization reform, thus financial liberalization degree kept increasing, the MO/M1and M0/M2ratio kept decreasing and was maintained at a relatively lower level, which indicated that with the advance of financial liberalization, the degree of financial repression in China had been decreasing constantly. Secondly, this paper analyzes the changes in money demand. Since the reform and opening up, the demand for money at all levels in China has shown a growing trend. Seen from the volatility of money amount at all levels, the stability has been enhanced. The standard deviations of the growth rates of M1from1978to1994and from1995to2011were0.097and0.057respectively, and that of M2from1978to1994and from1995to2011were0.062and0.048respectively, which seems to indicate that the progress of China’s economic and financial system reform could promote the stability of money demand in China. Corresponding to the demand for money is the velocity of money. During the period of1978-2011, the velocity of money in our country showed a trend of steady decline, which was also in line with the U-law of the money velocity fluctuation. Moderate fluctuation of money velocity seems to indicate the stability of money demand in China. The velocity of money and the economic cycle is not closely related, which means that the velocity of money is barely affected by the impact of the economic cycle. Therefore the stability of money demand is relatively higher. On the whole, the money growth rate and the money velocity change reversely, which is consistent with theoretical expectations.Chapter6makes empirical analysis on China’s money demand. Stable demand for money is a prerequisite for the central bank to make money supply as the intermediate target of monetary policy. As the Central Bank of China is still taking money supply as the intermediate target of monetary policy, this chapter makes empirical analysis on the stability of China’s money demand function. The money demand function illustrates the relationship between money demand and its decisive variables. Generally, the money demand function involves two types of variables:scale variables and opportunity cost variables. As a developing country which is in the process of economic transformation, China keeps implementing economic and financial system reform since1978and the degree of economic and financial marketization keeps deepening. During this period, economic and financial depth has undergone profound changes, and the demand for money is greatly influenced. Therefore, China’s money demand function should include institutional variables.In this study, it is assumed that the demand for money is a function of scale variables, opportunity cost variables and institutional variables. Through empirical testing, this paper selects the actual GDP and the actual market value of the stocks in circulation as the scale variables of money demand function, and degree of credit constraints, the expected rate of inflation and the real effective exchange rate as the opportunity cost variables of money demand function. It is worth mentioning that this paper does not select the actual interest rate as the opportunity cost variable. It takes the degree of credit constraint as the proxy variable of effective interest rate instead. This is because China’s interest rate is not market-oriented. As regulated interest rate, it cannot truly reflect the opportunity cost of money holdings. However, the degree of credit constraints could reflect the supply and demand situation of the capital market, and thus be able to better reflect the changes in the prices of funds. As China is still in the process of economic and financial system reform, the institutional changes would have a major impact on the demand for money. This paper selects M2/GDP as the institutional variable that affects the demand for money. The empirical results show that China’s long-term money demand function is stable, which provides the prerequisite for the monetary policy to take money supply as the intermediate target. However, short-term dynamic money demand function is not very stable due to the impact of the changing of opportunity cost. Comparatively speaking, the stability of M2short-term money demand function is better than that of M1, the Central Bank of China should therefore take M2as the intermediate target of monetary policy and M1as an important reference target.Chapter7makes an empirical study on the intermediate target of China’s Central Bank’s monetary policy--the determination of money supply. The operation of monetary policy mainly involves controlling the stock of money in order to achieve specific goals. It is assumed that the money supply is controllable, and there is a steady relationship between money supply and the ultimate goal of monetary policy, such as economic growth, price stability, etc. An important prerequisite for the central bank to take money supply as the intermediate target of monetary policy is the controllability of the money supply, which means that the money supply is exogenous. This chapter builds a money supply deterministic model as the basis of the empirical analysis. The money supply is determined by the base money and money multiplier, while money multiplier is determined by factors such as the statutory deposit reserve ratio, excess reserve ratio, cash-current deposits ratio, time deposits-current deposits ratio, etc. In general, the central bank could control the base money and the statutory deposit reserve ratio. Therefore, the control of the money supply depends on factors such as the excess reserve ratio, cash-current deposits ratio, time deposits-current deposits ratio, etc. The empirical results show that China’s money multiplier is basically stable and the base money has a far greater impact on money supply than money multiplier. Therefore, China’s money supply is mainly affected by the impact of base money. Viewed from the perspective of base money, although the increase in funds outstanding for foreign exchange makes a huge passive addition to China’s central bank’s base money, the central bank hedges large amount of funds outstanding for foreign exchange through policy tools such as deposit reserve ratio according to the goal of monetary policy. Therefore, it could be concluded that China’s central bank could control the base money. The conclusion of empirical analysis in this chapter is that the central bank can effectively control the money supply. M0/M1and M0/M2ratio was maintained at a high level before the1990s. Although China had conducted economic system restructuring for a long time before the1990s, financial liberalization still stayed in a relatively low level. High M0/M1and M0/M2ratio reflected that to certain extent considerable financing behavior had taken place in irregular financial institutions. After the1990s, China accelerated the pace of financial liberalization reform, thus financial liberalization degree kept increasing, the M0/M1and M0/M2ratio kept decreasing and was maintained at a relatively lower level, which indicated that with the advance of financial liberalization, the degree of financial repression in China had been decreasing constantly. Secondly, this paper analyzes the changes in money demand. Since the reform and opening up, the demand for money at all levels in China has shown a growing trend. Seen from the volatility of money amount at all levels, the stability has been enhanced. The standard deviations of the growth rates of M1from1978to1994and from1995to2011were0.097and0.057respectively, and that of M2from1978to1994and from1995to2011were0.062and0.048respectively, which seems to indicate that the progress of China’s economic and financial system reform could promote the stability of money demand in China. Corresponding to the demand for money is the velocity of money. During the period of1978-2011, the velocity of money in our country showed a trend of steady decline, which was also in line with the U-law of the money velocity fluctuation. Moderate fluctuation of money velocity seems to indicate the stability of money demand in China. The velocity of money and the economic cycle is not closely related, which means that the velocity of money is barely affected by the impact of the economic cycle. Therefore the stability of money demand is relatively higher. On the whole, the money growth rate and the money velocity change reversely, which is consistent with theoretical expectations.Chapter8conducts a study on the transmission mechanism and effectiveness of monetary policy launched by China’s central bank. Since the two prerequisites of the monetary policy effectiveness have been met, its transmission mechanism and effectiveness should be studied. The transmission mechanism of monetary policy includes monetary channels and interest rate channels, and this chapter sorts out these two channels in the theoretical way. Since the reform and opening up, China’s monetary policy has transformed from direct regulation to indirect modulation. Given China’s present situation, credit channel becomes the main channel of monetary policy transmission channels. Further empirical results show that the money supply can significantly affect the ultimate goal of monetary policy, which is economic growth and cost of living. However, the effect of interest rate is not very obvious. It shows that money policy launched by China’s central bank which takes money supply as an intermediate objective of monetary policy is effective.Chapter9is the conclusion of this paper.The innovation of this paper is reflected from the following aspects:First, the degree of credit constraints is included in the estimates of the money demand function. In most of the present related literatures, the official interest rate is taken as an important explanatory variable of the money demand function.But as China’s interest rate is not market-oriented, it belongs to regulated interest rates. Furthermore, because the currency market is not developed, its breadth and depth have significant limitations. This means that interest rates can not reflect the real opportunity cost of holding money.Therefore, official interest rate can not be used as the opportunity cost variable of our residents’money demand, and a new proxy variable reflecting changes in market interest rates needs to be found. Although interest rates in the informal financial market could reflect the supply and demand situation of the informal capital market, there still exist two issues:In the first place, the informal financial market is still underground and the interest rates in this market are difficult to observe; in the next place, the informal financial market is limited in scale and its interest rate is not enough to reflect the level of interest rates in the entire financial market. To do this, we use the credit constraint variables (one minus the ratio of newly added credit in the current year to GDP) on behalf of the market interest rate. Because of the prevalence of financial repression in developing countries, a large part of the enterprises’demand for credit can not be met by the formal financial market. The degree of credit constraints measures market interest rates level in a better way and explains the demand for money.Second, relationships between the velocity of money and the economic cycle and money demand are analyzed. According to classic economic theory, if the relationship between the velocity of money and the economic cycle is not close, it shows that the velocity of money is little affected by the impact of economic cycle, and therefore the money demand endures high stability. In addition, money demand and the velocity of money tend to move in a reverse way. The theory is analyzed and confirmed in this paper.Third, variables, such as the national income, stock market trading volume, the degree of credit constraints, the expected rate of inflation, the real exchange rate and institutional factors are included in the unified analytic framework of money demand. In the long run, China’s velocity of money appears stable. This means that although the impacts of each variable on money demand are not identical, the result of the combined effects will play a role of stabilizing monetary demand. For this reason, apart from the analysis of every separate variable, like scale variable, opportunity cost variable and system variable affecting money demand, how the determined variables combined together to affect money demand were also analyzed, explaining the stability of long-term monetary demand function and the short-term dynamic money demand function.Fourth, quarterly data from2001to2011are used to conduct an empirical study on the controllability of China’s money supply. Most of the existing literature states that China’s money supply is endogenous and the central bank can not control the money supply.One is that the money multiplier is mainly affected by the impact of opportunity cost variables, interest rate for instance. As interest rates change frequently, the money multiplier becomes very unstable; second is that the central bank can not control base currency, for example, for a long time, the central bank is forced to increase foreign exchange. But both of these analyses have limitations. Although money multiplier posses the characteristic of endogeneity, the combined effect of all the determined variables to money multiplier may keep it stable. Furthermore, even if the money multiplier is unstable in a certain period of time, it may have little impact on the money supply.At this stage, while the generation of base currency is of endogeneity, the central bank can effectively hedge against it with monetary policy tools like deposit reserve rates. In this way, the movements of base currency can be better controlled. Therefore, the central bank’s control to the money supply in the final analysis is an empirical question, which means data of a particular period needs to be used in the empirical analysis, since pure theoretical argumentation on the exogeneity or endogeneity of money supply have significant limitations. From the empirical analysis of the quarter data in the last10years, this paper shows that although the country’s money supply posses a certain characteristic of endogeneity, the central bank is able to control the movements of the money supply. |
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